At the start, it rarely feels necessary. Three friends or two siblings have just incorporated a company in Brampton. They trust one another, they are busy, and money is tight. Raising questions such as “what happens if one of us wants out?” or “what if you die?” can seem awkward, even a bit disloyal.
Those questions do not go away, though. They come back later, usually at a much worse moment: when one owner has stopped working but expects dividends, when a spouse inherits shares and starts asking for financial statements, or when two 50 percent owners cannot agree on anything and the bank wants a signature from both. Without an agreement, the parties are left with the general corporate statute and, if things get bad enough, a courtroom.
A shareholder agreement is a contract among a company’s owners, and often the company itself, that sets the rules for those situations ahead of time. This article gives a general overview under Ontario law. It is not legal advice, and each company’s agreement should be written around its own owners and plans.
What the Law Gives You Without an Agreement
Ontario’s Business Corporations Act provides a basic structure. Shareholders elect directors. Directors manage or supervise the business. Most decisions are made by majority vote, and some fundamental changes require a special resolution, usually two-thirds of the votes cast.
Consider what that means in practice. A shareholder with 51 percent can generally elect the whole board, and the board can decide on salaries, dividends, and whether to hire anyone. The person with 49 percent could end up with no job, no dividends, and no say. They have no automatic right to sell, no market for their shares, and no right to force a buyout.
The Act does provide remedies, and we discuss them below, but they mean litigation. Equal owners face the opposite problem: neither can outvote the other, so a disagreement can bring the business to a halt, and the statute offers no quick means of breaking the tie. A shareholder agreement fills these gaps.
Unanimous Shareholder Agreements
Ontario law recognizes a special type of agreement called a unanimous shareholder agreement, or USA. Section 108 of the Act allows an agreement among all shareholders to restrict the directors’ powers to manage or supervise the business, in whole or in part. Shareholders who take on those powers also take on the directors’ duties and liabilities to that extent, and directors are relieved to the same degree.
So a USA is more than a contract among friends. It can reshape how the company is governed, and a person who later buys shares is generally deemed to be a party. Owners who take decisions away from the board should understand that the associated liability may follow those decisions. Not every shareholder agreement needs to be a USA, but small companies often use this form because the shareholders and directors are the same people. Your lawyer should explain which form you are signing and why.
Who Decides What
Most useful agreements begin with control, because that is where day-to-day friction arises.
The board. Who gets to nominate directors? In a three-owner company, you might provide for each owner to appoint one director, as long as they hold a certain percentage of shares.
Reserved matters. A list of major decisions can require unanimous or high-majority approval. Typical items include:
- Issuing or redeeming shares
- Borrowing above a set dollar amount, or giving guarantees or security
- Selling the business or significant assets
- Hiring family members or changing owners’ pay
- Declaring dividends or changing the dividend policy
- Changing the nature of the business
- Starting or settling major litigation
- Entering into contracts with related parties
Make the list long enough to protect minority owners, but not so long that every purchase needs a meeting. Set dollar thresholds that make sense for your own business. An amount that would be major to a small Brampton bakery might be routine for a logistics company.
Roles and pay. Who works in the business, in what position, for how much, and what happens if someone stops? One of the most common sources of tension is a shareholder who remains an owner but no longer works there, while a partner handles everything. Addressing that possibility in advance can spare everyone a lot of resentment.
Money In and Money Out
Owners regularly assume they have the same understanding about money, and frequently they do not.
Spell out how much each person is contributing at the start, in cash, assets, or work, and record it properly. Decide what happens if the company needs more money. Must owners contribute in proportion? What if one cannot? Common solutions include shareholder loans with priority repayment or a dilution mechanism, but each carries its own fairness questions.
Record shareholder loans, including interest, repayment, and any security. In a hypothetical dispute, an undocumented $80,000 “loan” from a founder may turn into an argument over whether it was a loan at all, a gift, or a share subscription.
A dividend policy is also worthwhile. One owner may want profits paid out to support a family, while another wants to reinvest for growth. There is no single correct answer, but the agreement can set a default such as distributing a portion of profits after reasonable reserves, subject to the company’s solvency requirements and tax advice.
Getting Shares In and Out
Exit provisions are the heart of a good agreement. Without them, an owner who wants to leave may be stuck, and the remaining owners may find themselves in business with a stranger.
Restrictions on transfer. Most private companies’ articles limit share transfers. The agreement should add detail, including permitted transfers, such as moving shares to the owner’s holding company or family trust, and what approvals are required.
Right of first refusal. Before selling to an outsider, an owner must first offer the shares to the other shareholders on the same terms. This keeps control among the existing owners while giving the seller an actual route out.
Drag-along and tag-along rights. A drag-along lets a majority sell the entire company by requiring minority owners to sell on the same terms, so that a buyer can obtain 100 percent. A tag-along protects minority owners by allowing them to join a sale by the majority rather than being left behind with a new controlling shareholder.
The shotgun clause. One owner names a price per share. The other must either buy the first owner’s shares at that price or sell their own at that price. It is fast and elegantly simple, and it can be a useful deadlock breaker, since whoever sets the price does not know which side they will land on.
It can also be unfair. If one owner has far more cash or access to financing than the other, a low offer may leave the weaker party unable to buy, and forced to sell cheaply. Shotguns also suit owners with equal knowledge of the business, not a situation where one owner runs operations and the other is passive. Consider a shotgun carefully, perhaps with longer financing periods or a restriction on when it can be triggered.
Death, Disability, Divorce, and Departure
Life events are predictable, even if their timing is not. A good agreement addresses them specifically.
Death. Shares normally pass under the owner’s will. Without an agreement, the surviving owner could wake up in business with a grieving spouse or adult children who have no experience with the company, and who may need income that the business cannot provide. Many agreements require the company or surviving owners to buy the shares from the estate, often funded by life insurance. Have the wording coordinated with the owners’ wills and tax planning. Insurance policies must be kept in force, and beneficiaries must match the agreement.
Disability. Define when it is triggered, such as an inability to perform duties for a set period, and how a buyout would work. Disability is harder to plan and insure for than death, and it should not be ignored.
Marriage breakdown. Shares can become an issue on a separation. Agreements may require that a spouse’s claim be satisfied without transferring shares and may encourage marriage contracts for the owners. A family lawyer should weigh in on this, since family property law has rules of its own.
Employment ending. Founders may want to “vest” shares over time so that someone who leaves after six months does not keep a third of the company. If an owner-employee is terminated, the agreement may require a sale of shares, and perhaps at a lower price if the departure is for cause. Those clauses need careful drafting to work together with employment law.
Setting a Price
A buyout clause without a workable price is an invitation to a fight. Common methods include a figure agreed upon by owners each year (which works only if people actually update it), a formula based on earnings or book value, or a valuation by an independent chartered business valuator. Consider whether a minority discount should apply and whether the price is paid in full at closing or over time, with security. A sensible payment schedule protects the company from being drained of cash by a buyout.
Competing and Confidentiality
Owners commonly agree not to compete with the company or solicit its clients and staff, both while they are shareholders and for a period afterward. Ontario’s Employment Standards Act bans non-compete agreements with employees, subject to exceptions for executives and certain sales of a business. Where a shareholder is also an employee, the way the clause is drafted and the role that person holds can matter a great deal. Have the covenant reviewed so that it is reasonable in scope and not simply copied from an American template. A non-solicitation and confidentiality clause is also a good idea.
Deadlock and Disputes
Equal ownership is common in family and friend ventures, and deadlock is its natural hazard. Build in a process: perhaps a period of negotiation, followed by mediation, followed by arbitration on specified issues or a buy-sell mechanism. Arbitration clauses can keep disputes private, which many family-run businesses value highly, though you should weigh up the cost and the limited appeal rights.
Even with a good agreement, disputes occur. The oppression remedy in section 248 of the Business Corporations Act allows a shareholder and certain others to ask a court for relief when the company’s conduct is oppressive, unfairly prejudicial, or unfairly disregards their interests. Courts have wide powers, including ordering a buyout. A clear shareholder agreement often helps define what the parties could reasonably expect, which can narrow a dispute considerably. When matters have already reached this stage, advice on business litigation may be the next step.
When to Sign and How to Keep It Current
The best time to sign is when everyone is on good terms, usually around the time the company issues its first shares. If you missed it, do it now. Getting agreement is still possible as long as nobody is yet in a dispute.
Each owner should have the opportunity to get independent legal advice. It makes the agreement sturdier and the discussion more honest. Then review it when something major changes, such as when an investor comes in, an owner marries or divorces, the business grows considerably, or a child joins the company. Make sure insurance, wills, and corporate records all line up with it.
If you are forming a company or have been running one without an agreement, the firm’s corporate law team can help you think through the terms. You may find that the conversation itself is half the benefit: it shows you where the owners’ assumptions differ while there is still goodwill to resolve the differences. Learning that you and your co-founder have very different views about dividends is far more manageable now than it would be during your first real disagreement over money.